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Better Than Average

April 25th 2014

If you ask someone a random question of how good they think they are, the chances are they’ll respond with seven out of ten.  It almost does not matter what skill you’re asking about.  While it's impossible for most people to be above the median for a specific quality, people think they are better than most people in many arenas, from charitable behaviour to work performance.  It’s called illusory superiority.

Driving is the most often quoted example.  Studies in the US, Europe and Australia consistently return figures of between 69% and a whopping 93% of drivers believe they are better than the norm at driving.  Only 18% come back with a view that they are worse than average – and perversely it may be that many of these are actually more perceptive than the majority and hence better drivers on the road.

The same effect applies to both entrepreneurs and investors.  Whilst entrepreneurs have to have a bullet proof self confidence and commitment, perhaps it’s time for investors to see what behaviour actually works.

Recent quantitative data reveals some interesting conclusions.  Firstly, investors seem too keen to get involved too early.  Many investors invest 2-3x more capital than necessary in startups in the discovery phase.  They also over-invest in solo entrepreneurs and founding teams, rather than waiting a little longer for a degree of maturity.  This is partly because startups need 2-3 times longer to validate their market than most entrepreneurs and initial investors expect. 

Secondly, investors tend to believe overestimates of market size.  Startups that haven’t raised money and proven market uptake – even in trials or proof of concept stage - overestimate their market size by a huge 100x and often misinterpret their market as new.

Thirdly, canny investors know to almost always discount the value of the intellectual property in the startup.  Quantitatively, 72% of entrepreneurs find out that their initial intellectual property is not a sustainable competitive advantage.

Finally, the best investors know when to lend a hand and when to step back.  In reality executive help from investors has little or no effect on the startup company's operational performance – because in startup it’s the founding team’s drive and flexibility that count.  But the right non exec mentors significantly influence a startup’s achievement and ability to raise money.  Further, the right investors have a proven significant effect on valuations and M&A.

In a final cultural twist on illusory superiority, North Americans seem to be the kings and queens of overestimation.  If you go to places like Japan, Korea or China, this whole phenomenon evaporates. According to David Dunning, the leading  psychologist at Cornell who has studied the effect for decades, that is possibly because Eastern cultures value self-improvement, while Western culture tends to value self-esteem.

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